Setting compensation for senior management can be among the most contentious issues facing companies reorganizing under Chapter 11 of the US Bankruptcy Code. Corporate debtors argue that such compensation—often in the form of base salary, bonuses, or stock of the reorganised company–helps retain and incentivize management, whose services are believed necessary to achieve a successful reorganisation. Creditors, by contrast, may be loath to support compensation packages that they perceive as enriching the very managers who led the company into bankruptcy.

This tension over management compensation, though long present in corporate bankruptcy cases, has been more pronounced since 2005, when the US Congress added Section 503(c) to the Bankruptcy Code. Section 503(c) limits bankrupt companies’ freedom to give management retention bonuses, severance payments, or other ancillary compensation. For instance, under the current regime, a company cannot pay managers retention bonuses unless it proves to a bankruptcy court that the managers both provide essential services to the reorganising business and that they have alternative job offers in hand. Even then, the Bankruptcy Code caps the amount of the retention bonuses. Severance payments to managers are similarly restricted by Section 503(c).

Despite these restrictions, companies continue to search for ways to boost managers’ compensation in and around the time of bankruptcy. They do so because retaining existing managers is often the best way to maximise the value of the company in a restructuring. Existing managers typically have valuable institutional knowledge and industry-specific experience that is hard to replace. They may also be vital to preserving relationships with customers, employees, and suppliers. Recognising their value, leaders of bankrupt companies often demand incentives to stay on during bankruptcy. Even where a company would prefer new management, it can be hard to recruit top people to a bankrupt company undergoing a restructuring. Companies must therefore choose how and when to compensate managers without running aground on Section 503(c) and related provisions of the Bankruptcy Code.